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Zero-Bound Interest Rate: What Is It?

How zero interest rates affect the economy and the traders

As a trader in the foreign exchange market, how will you receive the news that the interest rate that you were supposed to carry was lowered or totally diminished? Such a situation means under the Federal Reserve’s policy, you were subjected to a zero-bound interest rate. To be in a position where you end up paying less for your stocks may seem advantageous. However, for somebody who’s unsure whether it’s a good thing, you couldn’t help but ask, “Is there a catch?”

What Does a Zero-Bound Interest Rate Suggest?

A zero-bound interest rate, or sometimes called zero nominal lower bound or zero lower bound, suggests that the Federal Reserve isn’t fit to increase interest rates. It is the procedure that follows a systematic approach to draw rates to 0. This is accomplished neither for the benefit of traders nor for a particular trade, but for the encouragement of economic growth.

Stock exchange market in New York
Zero lower bound or zero bound interest rates are designed to prompt economic growth,
by making finances available at extremely cheap rates.  (Image by Pixabay.com)

Problem, Problems, Problems

While a zero-bound interest rate may be helpful, a trader is somehow looking at a problem once his stocks are subjected to the zero-bound interest rate policy. It means that setting declining rates is necessary. Since the Federal Reserve does not hold the authority to set negative rates; once 0 is reached, the reduction of rates is stopped.

A zero-bound interest rate may not be a trader’s problem per se, but he may be affected (and he may be affected drastically in the future) since the economy is rather unstable. It is not simply a theory, but it is a real concern; during the 1990s and late 2000s, the Japanese and the US economies dealt with such a situation. Furthermore, with weak economic conditions, the Federal Reserve is considering new and different approaches to stabilize the economy.

A Solution

Concerns with a zero-bound interest rate can be resolved with the maintenance of average inflation rates; by initially setting a positive rate, the Federal Reserve has the opportunity to set a negative interest rate. Take, for example, the case of an individual who invested $5,000 on a particular year. If the inflation rate on that period were 10%, it means that instead of anticipating a return of $5,000, he is bound to receive only $4,500; a -10% interest (minus $500), under the zero-bound interest rate policy, was issued.

Content References: http://www.mtrading.in/education/

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